Q: What is surplus cash?
Surplus cash is the remaining cash balance after your business expenses, salary, Corporation Tax and declared dividends are deducted from your company income. Be aware that the cash balance in the bank is not always the same as your surplus cash. There maybe invoices that haven’t been paid or some business expenses or taxes that are still to be paid.
If you want to see what your surplus cash was last year-end, look at the Balance Sheet page of your accounts. At the bottom you’ll see a value for Profit and Loss. For your current surplus cash speak to your contractor accountant who will advise you accordingly.
Q: How does the national minimum wage affect a contractor?
It is generally accepted that paying a Company director or senior employee at levels below the national minimum wage (NMW) could be seen as un-commercial. Where that director is also a majority shareholder IR35 risks may be increased.
From 1 October 2013 the minimum wage rate for people aged 21+ was increased to £6.31 per hour, which for 35 hours a week and 52 weeks a year, comes to a little over £11,400 per annum.
Another indicator of when the NMW may apply to contractor and freelance situations depends upon whether or not the main director has a contract of employment with his Limited Company. If he does then the NMW should apply. If he does not have a contract then NMW does not have to apply but you should still be wary of a lower level seeming un-commercial in the eyes of HMRC.
Contractor wages taken under PAYE cannot be subject to increased taxation under IR35. For sensitive questions like this we want you to talk to us directly so contact us for an answer to your particular circumstances.
Q: What is the tax on dividends
Dividends paid from a company are deemed to be paid net of 10% tax, so if you take £5,000 your tax return will show you received £5,555 and paid tax of £555 (even though you haven’t actually paid anything you retain the benefit of the credit).
As dividends are taxed at 10% up to the higher rate band, the tax that is due has already been paid, so nothing further is due. When you cross into higher rates the tax due increases to 32.5%, less the 10% tax credit, so 22.5% – this works out at 25% of the money you actually received. This additional tax, if any, is calculated and paid for on your tax return.
From 06 April 2013 there is a new additional rate of 37.5% on dividends paid when total income is in excess of £150,000.
Q: What is the dividend tax rate?
Dividends paid from a company are deemed as paid net of 10% tax, so if you declare a dividend of £5,000 your tax return will show you received £5,555 and paid tax of £555 (even though you haven’t actually paid any tax you are treated as if you had). It is the gross value, being £5,555, that you are deemed to have received for tax band purposes.
Below the tax threshold rate
As dividends are taxed at only 10% up to the higher rate threshold, (which starts at £31,865 for 2014/15) the amount of tax that you are “notionally” deemed to have suffered at source is sufficient to cover this liability. Nothing further is due provided you have no other income in the tax year.
Above the tax threshold rate
When your total taxable income is greater than £31,865 (2014/15) plus your tax code, usually 1000L to give a basic rate band of £41,865, higher rates may be payable. Once into higher rates the tax due on dividends increases to 32.5%. The benefit of the notional 10% deemed to have been suffered remains, so 22.5% is the actual rate of tax charged on the gross dividend. Based on the net cash you actually receive the rate of tax is actually 25%. This additional tax, if any, is calculated and paid for via your tax return. If gross income is greater than £150,000 the rate of tax increases to 37.5% (less the 10% credit) = 27.5%, but only on amounts in excess of this limit. There are obvious attractions to using dividends in concert with salary and pension payments, but please speak to us personally to identify the risks and the advantages.
Q: What are dividends?
Contractors owning their own Limited Company have the advantage of being able to pay surplus profits to themselves via dividends as well as through a salary, which gives many advantages.
Dividends are not an expense of a business. Dividends paid to shareholders are an “appropriation” of profit (in other words how the profit is used). The main difference is that wages get tax relief in the Company and are deducted in calculating what the company’s profits are. The payments of dividends do not count as a business expense and are not deducted when calculating a company’s profits.
Unlike wages, dividends can only be paid from available net profits – that is cash or other assets remaining in the company after a provision for Corporation Tax. Care is required because the maximum dividend payable is not necessarily the same as the balance in the company bank account!
However, wages and dividends are also taxed differently.
Q: How do dividends and Corporation Tax work?
A dividend should only be paid from company profits. In order to calculate the profit you must take into account net sales, less expenses, and less an allowance for the expected Corporation Tax that will be due for the year. Anything that remains, plus or minus any retained profits or losses brought forward, is then available for dividend distribution.
When calculating your optimal pay structure you should keep in mind that dividends do not reduce the Corporation Tax you pay, whereas salary and pension contributions do.
This general advice must be taken in context with your overall tax and commercial circumstances before you decide what is best.
Q: What about tax and a personal pension?
A Limited Company can pay up to £40,000 per year into an employee’s personal pension, and will get Corporation Tax relief for those contributions. You should ensure that the payments go direct from the company bank account to the pension provider.
Pension contributions are also an allowable deduction for IR35 deemed salary calculations.
Before making any payments you should discuss with your Independent Financial Advisor to ensure you are fully aware of all the facts.
Q: What tax do I pay on my dividends?
If you have a normal tax code and you pay a salary of £10,000, you can take up to £28,678 in net dividends before paying any personal tax (assuming no other income such as bank interest, rental income or other salaries). If you withdraw anything above that £28,678 (up to the additional limit) you can expect a tax bill of 25% of the amount you take — so if you take £40,000 in dividends, the tax will be £2,831 (25% of the extra above £28,678).
Dividends above the additional rate limit will be taxed at 30.6% of the amount you take (or 37.5% of the gross).
Q: What do I need to know about taking dividends?
It is efficient to take any further income in the form of a dividend. In the hands of an individual dividends are effectively tax free up to the higher rate income tax limit, and taxed at 25% of what you take above that. The tax rate increases at the additional rate limit, but only if your total income exceeds £150,000.
A dividend is simply a transfer from the company bank account into your personal account, with the appropriate dividend voucher completed (we supply a template for you to use). Any dividend transfers should be kept totally separate from payments made for wages or expenses so that HMRC can clearly identify them if necessary.
Q: How do I take a tax efficient salary from my Limited Company?
The salary level you chose to take is up to you but we recommend you set it at not less than £7,956, which is the lowest level you can pay and still get credit for NI purposes (which is important for certain state benefits). If you would like to be less aggressive you could set a level equal to National Minimum Wage — around £11,000 to £12,000 a year. This is deemed by some to be a more commercially realistic level, and remunerating yourself below this level has been shown to be disadvantageous if debating IR35 issues with HMRC.
In the current fiscal year, up to 5 April 2015, assuming your company qualifies to claim the Employer Allowance, the most tax efficient salary to take is that equivalent to your tax code (generally £10,000 per annum or 1000L).
Q: What are the limits on dividends?
There are two factors you should consider when thinking about the limits on dividends – the company and you personally.
A company can only pay dividends from profits, so you should review your accounts to determine what the available profit is. This is not as simple as the balance in the bank account as accruals have to be made for various taxes. If you are not sure then simply ask us, and provided your portal is up to date we can prepare management accounts for you.
From a personal point of view you should then consider the impact that a dividend will have on your own individual tax liability. What other income do you have in the current tax year and what, if any, further liability will result from this dividend? Are you taking out enough to cover the money you need plus the tax that will be due? Again, if you are unsure then please feel free to ask your Client Manager who will be able to review your tax position and advise on the implications.
Q: What do I need to know about Limited Companies and pay?
One of the most important principles to grasp early on is that the money in the company bank account does not belong to the directors, it can only be withdrawn in the form of wages, dividends, expenses or a loan.
A wages summary will be prepared and sent to you that sets out the amount to pay yourself each month, along with the payments that need to be made by the company to cover PAYE and NIC (if applicable). Expenses are simply the amount of money you have spent on behalf of the company and now need to reclaim. We recommend this is done on a monthly basis.
Q: How do I reduce my tax burden?
When you want to extract money from the business you have the choice of either paying a dividend to yourself as a shareholder (owner) of the business or paying yourself a salary or bonus as a director (employee). These two methods can be structured in a way that legitimately reduces the overall tax burden. Additionally a Limited Company pays Corporation Tax on its profits, after salaries have been deducted but before dividends. All of these different taxes are at different rates and work under different rules.
Q: How do I create timing advantages in the payment of tax
Rates of taxation and tax thresholds before the rates increase are set and may change every year in the budget. Using the flexibilities that come with your own Limited Company (and using the advice of an accountant) enables contractors to use these thresholds to their advantage and can also delay the payment dates of tax from one year to the next year.
Q: How do I use dividends rather than my salary
Dividends do not attract employers or employees national insurance tax (unlike wages).
Dividends are taxed differently under income tax. Dividends forming part of your overall personal income in a tax year receive a “tax credit” in the company when paid. Without any tax actually being paid the basic rate is assumed to have been paid by the company. So for the tax year 2014/2015 if total income including dividends is less than £41,865 no tax is payable on the dividend received (assuming the standard tax code). For income levels between £41,865 and £150,000 the effective rate of tax on the dividends is not more than 25% – Better than income tax rates of 40%!
Q: How do I only make taxable the income I need?
As an Umbrella or sole trader all of your income (after allowed expenses) is taxed as it is earned at the highest rate of income tax that applies. This is up to 40% for income levels up to £150,000, and even 45% beyond that (2014/2015). It is also difficult to manage the timing of this tax burden. BUT as an employee (director) of a Limited Company, you can choose the level of income you take as salary in any tax year and match it to your needs. Any undrawn or “surplus” amounts can be left in the business for the future and will be taxed once only at normally 20%. In the future when you need the cash, retire or exit contracting your can call upon these funds.
Q: How to profit from VAT?
By voluntarily registering your business for VAT and transferring to the Flat Rate scheme most contractors are able to make a “profit” from following the rules. It works because your business charges VAT to the end hirer at 20%, but only has to pass on a lower amount to HMRC (commonly 13-14%). The taxman assumes the difference is the amount of VAT you will suffer on costs and is happy. In reality the amount of VAT suffered by most contractors is much lower than this generous allowance and they benefit from the difference. The VAT surplus is treated as income and taxed in the company but nevertheless it remains generous.
Q: How do I claim more expenses?
No other method for trading as a contractor allows you to claim more expenses incurred by you and your business than those available when trading as a Limited Company. With very few exceptions expenses necessarily incurred for the purposes of your trade get tax relief in the company at the most common company rate paid by contractors of 20%.